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So we are in a recession. Now what?

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News that the Canadian economy is in recession is certainly by now no surprised. Our second recession in seven years, I may add. But confirmation of it was like releasing a watermelon from a rooftop and running down to the street to confirm it has splattered all over the pavement.

So where did we go wrong? Undoubtedly, the Conservatives will spin this every way they can and will probably claim that it was due to forces outside of their control, like the oil spill, and will probably throw in the slowdown in the Chinese economy for good measure.

While these events certainly contributed to our recession, they also point to a lack of leadership. Harper's Conservatives have steadfastly refused to engage in fiscal stimulus to encourage growth, at a time when it was clearly needed. The Keynesian consensus is quite simple: our economies grow on the strength of aggregate demand. When no one is spending, when demand is weak, the State has a moral obligation to do so on behalf of her people. In doing so, the State supports demand and helps bring the economy closer to full employment.

But under Harper, we have been told time and time again that fiscal policy has no real effect on the economy, and that only central banks can have an influence. This reflects the thinking of mainstream economists and its reliance on what I have called 'monetary dominance': the idea that only monetary policy can work.

But we know this to be wrong. The financial crisis of 2007 and the subsequent injection of stimulus then have shown how powerful fiscal policy can be: it stopped the GDP free-fall in its track, and even reversed it to some degree. What Keynesians knew before the crisis regarding the powerful role of the State should now be quite evident to all. 

So fiscal policy works. And yes, we will have to create a deficit, but there is nothing inherently wrong with deficit spending. We must stop this hysteria about deficits. It is not burdening future generations, like so many claim. Quite the contrary, it is ensuring that future generations have the proper infrastructure to maintain a healthy economy.

With respect to monetary policy, interest rates are so low already, that any further decreases will have negligible effects on the economy: interest rates cannot go below zero. So the Bank of Canada is limited or even powerless in the current situation. So in a way, that leaves only fiscal policy … and Harper refuses to use it.

So in the end, unless something happens, we are really dead in the water: monetary policy is confronted with a very real constraint of the lower bound, and the government refuses to use fiscal policy to stimulate the economy. So what is there left to do? 

We can't use monetary policy even if we wanted to. Rates won't go any lower. But we could and can use fiscal policy. In a way, fiscal policy and deficit spending is the only macroeconomic tool we have right now, so we must use it. 

If we don't use fiscal policy, we will of course eventually get out of recession, but our growth will be lacklustre, as it has been since 2007. We will hover around two per cent growth, unemployment will remain high (real unemployment is closer to nine per cent once you factor in declines in labour market participation), and incomes will keep flatlining.

Welcome to stagnation. 

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